White House aims to keep federal role in mortgages

by Zachary A. Goldfarb - Aug. 16, 2011 12:00 AMWashington Post

President Barack Obama has directed a small team of advisers to develop a proposal that would keep the government playing a major role in the nation's mortgage market, extending a federal loan subsidy for most homebuyers, according to people familiar with the matter.

The decision follows the advice of his senior economic and housing advisers, who favor maintaining the government's role as an insurer of mortgages for most borrowers. The approach could even preserve Fannie Mae and Freddie Mac, the mortgage-finance giants owned by the government, although under different names and with significant new constraints, people knowledgeable about the discussions said.

The president's decision to preserve a major role for the government marks a big milestone in the effort to craft a new housing policy from the wreckage of the mortgage meltdown and could mean a larger part for Fannie and Freddie than administration officials had signaled.

In a statement, the White House said it is premature to say that senior officials have agreed on any of the three main options outlined earlier this year in an administration white paper on reforming the housing-finance system.

"It is simply false that there has been a decision to move forward with any particular option," said Matt Vogel, a White House spokesman. "All three options remain under active consideration, and we are deepening our analysis around how each would potentially be implemented. No recommendation has been made to the president by his economic advisers."

The proposal is likely to draw criticism from many Republicans, who blame the financial crisis on policies that they say overly encouraged the housing market. And many economists, including some who have worked in the White House under Obama, consider the federal role harmful to the free market.

But if this approach became law, it probably would keep in place the kind of popular home loans that have been around for decades: 30-year fixed-rate mortgages with relatively low interest rates.

Officials have not determined whether to advance a final proposal before the 2012 presidential election. Officials from the White House, the Treasury Department and the Department of Housing and Urban Development are working out the details.

The government could maintain a substantial role in various ways. These include restructuring Fannie and Freddie as public utilities overseen by a government regulator.

The government would no longer guarantee their financial health, as in the past, but would continue to backstop the mortgage-backed securities they issue using loans made by private banks.

Or the two companies could be shut down and replaced with several successors that, likewise, would have their mortgage-backed securities guaranteed by the government in exchange for a fee. A federal guarantee, by reducing the risk to investors, can make it cheaper for firms to raise money for making home loans, in turn reducing mortgage rates.

For years, Fannie and Freddie, shareholder-owned companies chartered by Congress to support the housing market, owned or insured trillions of dollars in home loans. When the housing market crashed, the government seized the companies, and it has spent more than $150 billion propping them up.

Since then, Fannie and Freddie have played a key role in ensuring the availability of mortgages amid the market upheaval. But the Obama administration has said it wants to scale back the federal role.

In weighing whether to preserve Fannie and Freddie, administration officials have several concerns, said people familiar with the discussions who spoke on condition of anonymity because the talks are still preliminary.

The companies spent decades developing a market in which investors worldwide can buy and sell securities backed by U.S. home loans, and administration officials don't want to jeopardize that.

Officials don't want to punish the thousands of Fannie and Freddie employees who have specialized knowledge about the mortgage market and had nothing to do with the poor business decisions top executives made in the run-up to the financial crisis.

But some critics warn that nearly any government role could leave taxpayers on the hook.

"The long-term consequence is that the taxpayers ultimately have to bail out the government's losses," said Peter Wallison, a fellow at the American Enterprise Institute. "There is only one legitimate role for government in guaranteeing mortgages. That is mortgages for low-income people, to enable them to buy homes."

Under the approach Obama endorsed, the government would seek to limit the exposure of taxpayers.

Fannie, Freddie or other successor companies would charge a fee to mortgage lenders and banks and use the money to create an insurance pool to cover losses on mortgage securities caused by defaults on the underlying loans.

The government would be the last line of defense in case of another housing-market meltdown, using taxpayer money to cover losses only if the insurance pool ran dry.

Some special advantages awarded to Fannie and Freddie would be eliminated, according to people familiar with the matter.

For example, the two companies were allowed for decades to do business while holding a fraction of the reserves - essentially, rainy-day money - that banks and other financial firms were required to hold. This advantage allowed Fannie and Freddie to grow large.

The companies, or the firms that replace them, would have to start holding much more in reserve.